Tackling High Interest Rates The Main Task

The monetary policy is not an end in itself but a means to address these problems and bankers hope the RBI will do the needful.

The most acute problem facing the central bank is the high interest rates despite a lack of credit demand.

In fact, very rarely has the bank credit fallen continuously till September as it has done in the current year.

In 1996-97, bank credit up to September 13, 1996, has fallen by a massive Rs 6,739 crore to touch Rs 2,47,311 crore. As against this, in the corresponding period of the previous year, credit rose by Rs 3,149 crore. The problem of credit offtake can be related to the high interest rates, said a banker.

 

It is felt that the high rates have led to a slowdown in industrial growth due to which the demand for credit is down. That apart, corporates expect the interest rates to come down and are hence holding back borrowings. The problem is acute for banks as they have witnessed a large increase in aggregate deposits but no remunerative avenues to invest the money in.

When there has been a fall in credit, aggregate deposits have grown by Rs 20,034 crore between March 31, 1996, and September 13, 1996. The is an exponential growth compared with the same period last year when deposits grew by Rs 1,457 crore.

In a sense, the situation prevailing in last six months is exactly the opposite of the one that prevailed in the previous year when there was a strong demand for credit but no deposits to feed it. In the current year, there is a surplus of deposits but no credit demand. Hence, funds are being invested in the unremunerative government securities.

In order to increase credit offtake, the RBI is looking at cutting the cash reserve ratio (CRR). Bankers expect the RBI to slice the CRR and proportionately reduce export refinance and also slash deposit rates.

If these three happen, the interest rates are bound to go down. In fact, the RBI is likely to ask banks to cut their lending rates if it wants a cut in the CRR, opined another banker.

The problem of decelerating growth is attributable to many reasons including high interest rates on the monetary side. By cutting the CRR, at least the monetary side of the problem will be taken care of, the banker said.

A contradiction faced in the banking system today is the rapid growth in money supply and a fall in reserve money. Money supply between March 31, 1996, and September 13, 1996, rose by Rs 32,559 crore which is an increase of 5.4 per cent. Reserve money, on the other hand, fell by Rs 6,141 crore up to September 13, 1996, which is a fall of 3.2 per cent.

In the current scenario, if there is a further injection of liquidity into the system, the money multiplier will go haywire. This will have adverse implications on inflation.

In fact, the central bank governor has recently stated that inflation control will remain one of the main objectives of the monetary policy, creating doubts in the minds of the banking community on whether the CRR will be actually cut.

The sluggishness in exports has created a host of problems for the RBI. It was reportedly in favour of phasing out the export refinance totally and in lieu of the CRR cut.

However, with the sluggishness in the exports, it is felt that refinance will continue. The RBI is reportedly not in favour of this as it will leave an avenue for banks to draw funds even after the CRR cut.

Another problem area is repayment hump on the forex side. For this, the central bank is expected to introduce a series of measures to increase foreign exchange inflow. Bankers expect the RBI to allow commercial banks to create foreign currency assets in the country to bring the FCNR(B) deposits into the country.

The central bank is also likely to allow foreign institutional investors to invest in government paper, increase the investment limits of banks in shares and stocks from the existing 5 per cent, allow trading in the secondary share market and fix the spread that banks can charge between the prime and non-prime borrowers.

Bankers also expect the RBI to increase the loan component in the maximum permissible bank finance (MPBF) from the current level of 60 per cent. The balance in the MPBF is drawn in the form of cash credit.

The central bank is also expected to increase the stock lending limits to individuals from the current level of Rs 10 lakh. Banks are at present allowed to invest five per cent of the previous years deposits in stocks and shares and another five per cent in bonds and debentures. Bankers have asked the RBI to increase the limit for investment in stocks and shares. Sources in the financial sector are bullish about the increase in the investment limits. It is felt that the RBI might allow banks to trade in secondary stock market. Investments in equity is a major business of banks overseas.

However, it is felt that if the central bank allows banks to trade in the secondary market, only the strongly capitalised, profit-making ones will be allowed initially.

Bankers feel that the RBI will not cut CRR by more than one percentage point in the monetary policy.

The RBI will cut the CRR only by 0.5 per cent and then go for the cut in phases till March 1997. By March 1997, the central bank will aim to bring the effective CRR to 10 per cent, which means it will cut the reserve ratio by 1.5 per cent. a banker said.